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Capstone Turbine Needs a Montage

There has to be a way to condense the time before Capstone reaches profitability.

If you love '80s movies, you know that one of the best parts of those films is the montage. It generally involves watching a down-on-his-luck character train really hard in eccentric ways until he's ready to win a big karate match or an arm-wrestling tournament. It's a great plot device, because it can help to condense what should be months of practice into what's basically a two- to three-minute music video.

Unfortunately, we don't get montages in real life. If we did, I'm sure that investors in Capstone Turbine (NASDAQ:CPST) would want one, to watch the slow march toward potential profitability in short order.

Getting over the topInvestors who have followed this company know that it's been a slow and arduous process to try to get quarterly income into the black. At least the company is consistent: This past quarter, it posted yet again another loss, continuing its streak of losing money every year since its public offering in 2000. Many investors have hung on to the company through thick and thin, thinking that its superior co-generation technology would be enough to bring it to profitability. But it looks as though 2012 marked a time when investors finally started to lose patience, as shares of Capstone suffered an almost 30% haircut in the past year.

If there's one encouraging sign to come from this loss, it's that the company is still heading in the right direction. This quarter saw only a per-share loss of $0.01, another uptick from a $0.03 loss year over year. Capstone also posted its first double-digit gross margin ever this quarter. Thanks to these kind of trends, analysts estimate that Capstone can finally expect to reach profitability in 2015.

Sources: Capital IQ, authors calculations

If the company can continue down this path and reach management's stated goal of 35% gross margins, then profitability should follow.

You're the best aroundOne of the reasons the company has had such a hard time reaching profitability is its industry. As a manufacturer of co-generation turbines, the company is in a space dominated by industrial giants General Electric(NYSE:GE), United Technologies' (NYSE:UTX) Pratt & Whitney Division, and Caterpillar(NYSE:CAT). The offerings for each company feature incredible efficiency ratings -- Caterpillar's co-generation engines rate the highest, with a 96% efficiency rating.

What makes Capstone unique, though, is that it's able to build a co-generation turbine at a small scale and run on multiple types of fuel, something that none of its competitors can claim. This makes Capstone a much more viable option for smaller-scale power needs, such as commercial and residential markets. What's keeping the company from breaking through in the market, though, is that most Capstone products sell at a 30% premium to the competition. The company has gone to great efforts with its distributors to emphasize that the lifecycle costs with its products outweigh the premium paid, but in some cases it just hasn't been enough to justify the sticker price.

Capstone has also gone to great lengths to foster better relationships with one of its best customers: remote oil and gas drilling operations. Since the company's turbines are able to consume several different types of fuel, they can be very handy for powering drilling operations that are off the grid. In the past two years, oil and gas exploration has gone from 25% of sales to more than 66% for the company.

Not only are these products selling in the U.S., but shale gas plays around the world are also taking notice of the benefits that these generators can provide. Today, Capstone sells its products in multiple countries in South America, Europe, and Asia. With oil and gas exploration still growing at a rapid pace in the U.S. and abroad, it's likely that Capstone could find a very strong demand for its products from this customer base.

Here I am, not rocked by the hurricane Hurricane Sandy, which caused billions of dollars in damage in New York and New Jersey, was quite possibly the greatest unintentional advertising campaign Capstone could have ever asked for. All but one of its turbines remained fully operational throughout the storm. With more recent storms in the Northeast causing several hundred thousand power outages, it's likely that people will look to other forms of power generation for their electricity. And in the wake of Sandy, the New York State Energy Research and Development Authority just announced a multimillion-dollar initiative to encourage the use of co-generation systems. Several of Capstone's products fit the criteria for the initiative, so it's possible that Capstone could see a large boost in critical power systems sales thanks to this initiative.

What a Fool believesThere are still a lot of ifs in the Capstone story before the company will see profitability: if Capstone can continue to court off-grid oil and gas operations, if it can keep up its cost reduction plans to increase margins, if it can build out a stronger distribution network and warranty service. A lot of pieces need to fall into place.

That's not to say it's impossible, though. The momentum, albeit slow, is on Capstone's side. It's probably going to take longer than a montage to get there, so investors who have hung on for the ride will need to hold tight for a bit longer before they see any profits from this company.

Fool contributor Tyler Crowe has no position in any stocks mentioned. You can follow him on Fool.com under TMFDirtyBird, Google +, or Twitter: @TylerCroweFool.